The Second Circuit recently took up the insurance coverage dispute arising out of the high profile enforcement action the SEC pursued against hedge fund Patriarch Partners and its CEO, Lynn Tilton. The district court had ruled that coverage under the firm’s third level excess D&O insurance policy for the expenses the firm incurred in defending the SEC action was precluded because the agency’s investigation preceded the policy’s “prior and pending” litigation date. The Second Circuit affirmed the district court, but not on the grounds on which the lower court had relied. Rather, the appellate court affirmed the district court ruling based on its conclusion that coverage was precluded under language in the warranty statement the firm submitted for the excess insurance policy. The opinion includes interesting discussion of the issues surrounding the warranty statement. The Second Circuit’s December 6, 2018 Summary Order in the case can be found here.



Patriarch Partners is a private investment firm run by its founder and CEO, Lynn Tilton. Patriarch and Tilton were the target of a long-running SEC investigation that led to the SEC filing an Enforcement Complaint against them in 2015. In the enforcement action, the SEC asserted fraud charges against Tilton and Patriarch, accusing them of hiding the poor performance of loan assets in three collateralized loan obligation (CLO) funds they manage. The SEC alleges that Tilton and her firm collected almost $200 million in fees and other payments to which they were not entitled. Patriarch and Tilton ultimately were successful in the defense in the enforcement action. In September 2017, an SEC Administrative Law Judge dismissed the SEC’s action against them.


Patriarch and Tilton were insured under a $25 million tower of D&O insurance. The top $5 million layer was added at the time of the renewal of Patriarch’s program in 2011. The $5 million layer is written on a “follow form” basis, meaning that its terms and conditions follow the terms and conditions of the primary D&O insurance policy in the Patriarch insurance program.


In the course of their defense of the SEC’s investigation and enforcement action, Patriarch and Tilton exhausted the first $20 million of the Patriarch D&O insurance program. Patriarch then sought to have the insurance under the top $5 million excess layer applied to their cost of defense. The excess insurer denied coverage for expenses and Patriarch filed a coverage lawsuit against the excess insurer.


As discussed here, on September 27, 2017, Southern District of New York Judge Valerie Caproni granted the excess insurer’s motion in the coverage action for summary judgment, ruling that coverage under the excess insurance policy was precluded because the SEC’s investigation, which represented a Claim under the policy, preceded the policy’s prior and pending litigation date. Patriarch appealed the district court’s ruling.


The History of the SEC Investigation

The history and timing of the SEC’s investigation was critical both to the district court’s analysis and to the Second Circuit’s subsequent consideration of the coverage dispute. The SEC’s investigation began in December 2009 when the SEC made an “informal” request to Patriarch for documents relating to certain investment instruments. The SEC followed up with additional document requests in June 2010 and September 2010. In May 2011, the SEC requested additional documents as part of what it called an “informal investigation.”


In May and June 2011, the SEC also sought documents from two former Patriarch executives, Todd Kaloudis and Meric Topbas. After discussions with the Topbas’s counsel, the SEC agreed to subpoena the documents it sought from Topbas. The Topbas subpoena was issued pursuant to an SEC formal order dated June 3, 2010, authorizing the investigation of Patriarch. The Formal Order of Investigation authorized the SEC to issue subpoenas, compel document production, and take evidence in connection with the investigation. The Formal Order also stated that the SEC has information that “tends to show” that “certain persons and entities involved in structuring and marketing” the investment instruments under investigation “may have been or may be … employing devices, schemes, or artifices to defraud” investors and clients, “in possible violation of the securities laws.”


On July 5, 2011, Patriarch’s outside counsel met with the SEC to provide information. On August 11, 2011 (the day before the excess policy was bound), the SEC followed up the meeting with an email request for specific information concerning a specific investment vehicle. In the email, the SEC noted that it intended to follow up the email request with a subpoena that might seek additional information. Patriarch’s outside counsel sent a copy of the SEC’s email to Tilton, and Tilton responded back to counsel’s email.


The SEC sent Patriarch a subpoena for documents on February 27, 2012. On March 5, 2012, Patriarch’s broker advised the insurers in the D&O insurance program, including the excess insurer, of the SEC’s investigation. The primary insurer and the other insurers in the program accepted the SEC’s February 27, 2012 subpoena as a Claim.


Background Regarding the Excess Insurance Policy

In July 2011, Patriarch was in the process of renewing its D&O insurance policy. During the process, Patriarch’s insurance broker recommended that the firm increase its insurance program from $20 million to $25 million by adding an additional $5 million layer of excess insurance. The broker obtained a quote for the additional excess insurance contingent on Patriarch’s execution of a warranty statement. Tilton executed a warranty statement dated August 12, 2011.


The warranty statement stated, among other things that “neither the undersigned nor any other director or officer of Patriarch is aware of any facts or circumstances that would reasonably be expected to result in a Claim under the Captioned Policy.” The statement went on to say that “It is understood that the Captioned Policy and any renewal thereof does not provide coverage for Claims relating to facts or circumstances that, as of the date of this letter, Patriarch was aware of and would reasonably have expected to result in a Claim covered by such Captioned Policy (or future renewal thereof).”


The Second Circuit’s Order

In a December 6, 2018 Summary Order issued by a unanimous three-judge panel, the Second Circuit, applying New York law, affirmed the District Court, ruling that because Patriarch’s claims are precluded by the exclusionary language in the warranty statement, the appellate court did not need to reach the grounds relied on by the District Court.


In reaching its conclusion regarding the warranty statement, the court rejected the arguments Patriarch raised in contending that the warranty statement did not preclude coverage. Patriarch had first argued that the warranty statement’s exclusion precluded coverage only for Claims relating to facts and circumstances of which Tilton was aware as of August 12, and that as of that date Tilton was not aware of the SEC’s Order of Investigation. Patriarch also argued that the warranty statement’s reference to a “Claim under the Captioned Policy” and a “Claim covered by such Policy” referred only to Claims giving rise to losses in excess of $20 million.


In rejecting Patriarch’s argument about Tilton’s knowledge, the appellate court said that because the warranty statement referred to facts or circumstances of which Patriarch is aware, the facts or circumstances known to Patriarch’s other officials and representatives is also relevant, and not just those known to Tilton. Among other things, the appellate court said the knowledge of Patriarch’s outside counsel is relevant.


The appellate court also rejected Patriarch’s argument that the warranty statement called only for information about Claims that might exceed $20 million, saying that reading the warranty as a whole and taking into consideration its context and purpose, the court was not persuaded by Patriarch’s argument.


The appellate court noted that the excess policy was written on a follow form basis, so that the same claims that are “covered by” the primary policy are also covered by the excess policies in Patriarch’s program. The fact that the excess insurer’s policy was an excess policy does not change or limit the class of Claims for which it provides coverage, it changes only the circumstances under which the excess insurer must pay for losses resulting from such claims. The “only reasonable interpretation of the Warranty” is that it excludes claims arising from facts and circumstances of which Patriarch was aware as of August 12 and that Patriarch would reasonably have expected to result in a Claim as defined by the primary policy.


The appellate court said by August 12, Patriarch “was aware” of the SEC Order of Investigation, the escalating severity and focus of the SEC investigation, the subpoena of a former employee, and on notice of an impending subpoena to be issued to Patriarch itself. The company was also aware of its own rapidly accumulating legal expenses involved in responding to the SEC.


The appellate court concluded that “contrary to the representations made in the warranty,” Patriarch was “aware” that the SEC had become more – not less – insistent in its demands of Patriarch. These “are facts and circumstances that could reasonably be expected to give rise to a Claim” under the excess policy. The Warranty thus “excludes Patriarch’s losses arising from its defense of the SEC Investigation Claim from coverage under the Axis Policy.”



Some readers may find it surprising that the Second Circuit affirmed the district court on different grounds that those on which the lower court relied and without even considering the grounds on which the district court had ruled. However, it is axiomatic that an appellate court may affirm a lower court’s ruling on any ground supported by the record.


The appellate court did not expressly say so, but it may have considered the warranty statement issue to analytically precede the prior and pending litigation exclusion issue on which the district court ruled – and having found the warranty issue to be decisive, there was no need for the appellate court to reach the prior and pending litigation exclusion issue. Or I suppose deciding the case the way it did allowed the appellate court to avoid the thorny and arguably elusive issue of when in the sequence of events the SEC’s investigation became a Claim for purposes of the prior and pending litigation exclusion.


For those of us on the policyholder side of the house (as opposed to the insurer side of the house), any preclusion of coverage based on a warranty statement is always troubling, as we are frequently called upon to consult with companies we represent on application, representation and warranty issues. There is a particular aspect of the appellate court’s analysis that seems particularly troubling, and that is the breadth of the scope of persons whose knowledge the appellate court said may be considered in assessing the warranty statement made on behalf of the applicant company.


To be sure, the language of the warranty statement itself used here fairly puts the applicant company on notice that the knowledge of the applicant’s officers and directors is relevant for purposes of the warranty the company is providing.  The warranty statement required the signatory to attest that “neither the undersigned nor any director or officer of Patriarch is aware” of the referenced facts or circumstances. In the case of Patriarch, that was unusually straightforward, as Tilton was Patriarch’s sole officer and employee.


However, in holding that Tilton’s knowledge alone was not the only relevant inquiry, the court broadened the scope of persons whose knowledge is relevant beyond just officers and directors. In determining what Patriarch “was aware of,” the court said it would consider not just the facts and circumstances known to Tilton, but also to facts and circumstances known to Patriarch’s outside counsel and Patriarch’s in-house counsel.


Broadening the scope so far as to bring in outside counsel’s knowledge is, to me, a surprise. I doubt few insurance applicants called upon to answer a similar warranty statement considers or attempts to determine whether their outside counsel is aware of facts of circumstances called for by the warranty statement.


Whether or not knowledge of a company’s outside counsel fairly can be said to be the knowledge of the company, it seems to me that the facts and circumstances known to outside counsel arguably is more than a warranty statement fairly should require. Indeed, from the applicant company’s perspective, the universe of persons whose knowledge may be considered knowledge of the company should be more circumscribed than the court assumed here.


It could be argued that the warranty statement itself should expressly circumscribe the breadth of persons whose knowledge can be ascribed to the company. For example, the warranty statement might say something like: “for purposes of identifying the knowledge or awareness of the applicant organization of any facts or circumstances that may give rise to a Claim, only the knowledge or awareness of the following persons may be imputed to the organization: the organization’s board of directors; its Chief Executive Officer; its Chief Financial Officer; and its General Counsel.”


The question of whose knowledge is relevant arguably was particularly important here. Tilton had submitted a sworn statement saying that as of the date of the warranty statement, she was not aware of Order of Investigation. Arguably, if only Tilton’s knowledge were relevant, the question of whether or not the subsequent Claim is excluded under the policy represented a disputed issue of fact precluding the entry of summary judgment. Of course, coverage might still have been barred under the prior or pending litigation exclusion as the district court held, but that was not the basis on which the appellate court decided the case.


Even if coverage might otherwise have been precluded, the question of whose knowledge is relevant for warranty statement purposes is an important one. It is  clearly a consideration that should be taken into account for anyone completing a warranty statement, or who is advising someone completing a warranty statement.